If there is one taboo in government, it is mentioning the unmentionable: the ERM. The memory of Black Wednesday haunts John Major - as well it might since his administration has never regained the reputation for economic competence it lost in September 1992. How awkward therefore that the clanking ghost of the exchange rate mechanism is likely to reappear centre stage at the next council of European leaders - courtesy of a study demanded by the Prime Minister himself.

That study, currently being conducted in Brussels, examines the relationship between the "ins" and the "outs". No, this isn't some test only a dedicated follower of fashion can pass. Instead, it concerns the prospective relationship between members of a European Monetary Union - the ins - and those who do not qualify or who opt to remain outside - the outs.

Suspend your disbelief a moment and imagine that EMU does come into being on 1st January 1999. Disregard - as European leaders would have to - mundane issues of economic eligibility under the Maastricht Treaty and assume that the political willpower of the Franco-German axis prevails. Even under this scenario, it seems unlikely that more than half the current 15 members of the EU would participate in the birth of the euro. The question then is how the ins would rub along with the outs.

For all the talk about "variable geometry" - Euro-jargon for a multi- speed Europe - the divide that EMU will open up in the European Union is unprecedented. The potential for tension between the ins and the outs is manifest. A principal flashpoint is the relationship between the exchange rates of the outs and the new euro. Can the outs simply float against the euro while enjoying free access to the markets of the single currency bloc?

John Major's main purpose in calling for a study on the ins and outs was to ensure that Britain did not lose out in a new two-tier Europe. His fear is that the ins may exploit their power as a unified bloc by erecting barriers against the outs' right of access to the single market. The UK argues forcibly that there can be no question of discrimination between the two groups.

However, the European leaders who agreed to the study - hailed at the time as a British negotiating coup - had their own reasons for going along with the Prime Minister.

The French in particular are worried sick that they will lose out to fierce competition from outs benefiting from the cost advantage of cheap currencies.

They contend that the outs cannot have their cake and eat it: they cannot benefit from open access to the single market and exercise complete freedom over their exchange rates.

The French therefore say that the outs must disavow competitive devaluation and yoke their currencies to the euro.

In a parliamentary debate on EMU last week, Alain Juppe, the French prime minister, called for "a tight system of fluctuation margins" between the euro and other European currencies. Finance minister, Jean Arthuis, said it was not acceptable that "erratic monetary variations can, in a few seconds, wipe out real productivity gains obtained at the price of substantial sacrifices".

Needless to say, this cuts no ice with the British, scarred by the memory of Black Wednesday. They argue that imposing such a system would be to invite a re-run of the turbulence on the foreign exchange markets that first put paid to sterling's membership of the ERM in September 1992 and then caused the bands to be widened to 15 per cent a year later.

Already, then, the battle-lines are drawn, with both sides dug into entrenched positions. It hardly augurs well for an accord at the European summit in Florence, let alone for a post-EMU Europe. Yet there is an irony here: there should be no need for this conflict if Euro-propaganda in favour of EMU were right. For a key argument deployed by Euro-enthusiasts all along has been that depreciating your exchange-rate does not pay off.

This was clearly stated in the Commission's proselytising text, One Market, One Money in 1990. Changes in nominal exchange rates, it said, did not bring about a long-term improvement in competitiveness. Instead they offset differences in inflation rates. Countries that devalued ended up frittering away their initial cost advantage in higher inflation.

The trouble is that the experience of the devaluations since 1992 has so far proved the reverse. For once, depreciating countries have not thrown away their immediate gains in a subsequent inflationary surge. The decline in the pound and the lire have brought about a real gain in competitiveness: exchange rates have fallen in real as well as in nominal terms.

This was clearly demonstrated in a study conducted by the Commission on the effects of the exchange-rate turbulence of the early 1990s. This had been commissioned at the Cannes summit in June, following political pressure from French and German industries hit by the effects of the big devaluations against the French franc and German mark after Black Wednesday.

When the Commission reported back last autumn, it emphasised the longer- term trends in trade share from 1987 to 94. It argued that "structural factors largely dominated exchange-rate effects" over this period. It stressed that "past experience with devaluations shows that they have not brought lasting success in economic policy terms".

The reality, however, was that the study showed - to the Commission's embarrassment - that the devaluations of the 1990s had paid off. The pound fell by 11 per cent against other European currencies between the third quarters of 1992 and 1995. Only 4 per cent of this fall was thrown away in higher wage costs, leaving an overall fall in the real exchange rate of 7 per cent. Even larger gains in cost competitiveness were made by Italy and Spain.

The converse was also true: hard currency countries like France and Germany saw substantial increases in both their nominal and real exchange rates. Not surprisingly, German and French exports to their European partners were hit hard.

Between 1992 and 1994, the German share of total intra-European exports fell by 3 percentage points. France, which had enjoyed steadily rising export penetration of the European market, also suffered a reverse. Meanwhile, the UK share of total European exports rose by one percentage point.

No wonder the hard currency countries are insisting on a return to some form of ERM for the outs if EMU goes ahead. Wriggle though the British may in the negotiations ahead, Mr Major looks set to get more than he reckoned for from his ins and outs study.

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